Wednesday, August 29, 2012

Gordon on Growth

Gordon's paper is about the biggest and most important economic question of all: Long-run growth. It's easy to forget that per-capita income, the overall standard of living, only started to increase steadily in about 1750. The Roman empire lasted centuries, but the average person at the end of it did not live better than at the beginning.

Gordon's Figure 1, reproduced here shows how growth picked up in the mid 1700s, reached 2.5% per year -- which made us dramatically better off than our great-grandparents -- and now seems to be tailing off.

As Bob reminds us with colorful vignettes of 18th and 19th century living, nothing, but nothing, is more important to economic well being than long-run growth.

And modern growth economics is pretty clear on where the goose is that lays this golden egg: Innovation. New ideas, embodied in new products, processes and businesses. For example, see Bob Lucas' "Ideas and Growth" which starts

What is it about modern capitalist economies that allows them, in contrast to all earlier societies, to generate sustained growth in productivity and living standards? It is widely agreed that the productivity growth of the industrialized economies is mainly an ongoing intellectual achievement, a sustained ﬂow of new ideas

Growth theory neatly divides economics into "growth effects," which is really how fast new ideas are born and implemented, versus "level effects." Many economic distortions screw up the level, making an area or a country less well off than its neighbors. But so long as the frontier keeps growing, even level effects only retard a country a few decades.

Here's a picture. The red line represents 2% growth (real, per capita), starting at $100,000 income. By 2100 your great grandchildren are earning $738,000. The blue line shows a "level effect." Suppose some set of harebraned policies is so awful that it reduces the level of GDP by 20% -- but does not interfere with the growth mechanism. It's pretty bad. But the blue line is really just shifted to the right, lagging a decade or so behind but still participating in the eventual miracle.

By contrast, the black line says, what if there is a policy or change in the environment that has no effect on the level of GDP, but lowers the long-run growth rate to 1%. 2%, 1%, what's the difference? Cumulate that over a century, and your great grandchildren make $300,000, not $738,000.

OK, so, to Bob's first thesis: Long-run growth is slowing down. The big ideas of the first two industrial revolutions, roughly the harnessing of energy, urbanization, clean water, have been used as far as they can. The computer revolution, to Bob, seems to running out of its ability to raise productivity. 20-somethings updating their facebook profiles instead of paying attention class are not the jet-packs and rocket ships we thought we were going to have by 2001.

I think Bob has the right question here. And his warning is well-taken. Just because growth has been steady does not mean it's assured. The "trend" does not come for free. Each improvement in productivity takes hard work, and disruptive new companies putting established incumbents out to pasture.

But I think -- or at least I hope -- he has the wrong answer (and he freely admits this is speculative).

My pet theory is that the real defining innovation of growth was Gutenberg. Science gives us real knowledge, at last, by controlled experimentation. But controlled experimentation is extraordinarily expensive. A farmer can't afford to test which crops grow best, a country doctor can't do clinical trials. For society to gain knowledge by scientific method, we need communication. One doctor's clinical trials inform another doctor's practice a thousand miles away. Gutenberg made that possible.

More generally, the process of growth, of incorporating new ideas into the economy, almost always represents standing on the shoulders of giants, appropriating, slightly improving, and implementing someone else's ideas. That, for example, is why we see clusters of innovation such as Silicon Valley.

Well, if Gutenberg (and subsequent innovations that used his ideas, the newspaper, the scientific journal, and the public library) lowered the costs of communicating ideas and widened the community of people that a given idea could reach, the internet just did that tenfold. As I look at the cool stuff -- nanotechnology, genetic engineering etc. -- underway and the instant worldwide communication of ideas, I have hope we'll see that 2.5 percent again. If we let the process run.

For example, think how Bob's idea got to your desk. When I was a young economist, before the internet, he would have mailed a paper to the NBER, a month or two later the working paper would have been distributed. The internet buzz I saw that got me to go look at it would have taken a few more months to percolate to me by older information networks, then I'd have to go read it in the library. Finally, who knows how I would have gotten to you. That all happened in a week. The diffusion of ideas is on steroids.

Well, maybe my pet theory is wrong. Still, long-run growth is the issue, it is not guaranteed but hard-won, we didn't always have it and we could lose it, and that would be a catastrophe.

Bob prognosticates not only that we seem to have run out of productivity-increasing ideas, but that "six headwinds" stand in the way. His headwinds are 1) Demographics: aging and reduced labor-force participation 2) Plateau in US educational attainment 3) "The most important quantitatively in holding down the growth of our future income is rising inequality." 4) Globalization and outsourcing 5) Energy and enviroment 6) Household and government debt.

Here I think Bob is mostly confusing "level" effects with "growth" effects. He is also mixing constraints -- run out of ideas -- with self-inflicted wounds -- dysfunctional public education, refusing to let in immigrants, refusing to use nuclear power or GM foods. And, I don't see how he can focus on the US. Suppose we cede the frontier to, say, China, as the UK ceded the frontier to us in Bob's graph. But as long as we still use China's ideas and technology, and they grow at 2.5 percent, so do we.

The optimistic lesson of growth theory is that, no matter how badly you screw up level effects, growth will bail you out eventually. So, any "headwinds" need to be clearly linked to the possibility that economic distortions lower the rate of finding new ideas and incorporating them. The whole point of growth theory is that, in the long run, that's all that matters.

Do they? My impression of modern growth theory is that the economics of innovation production and adoption are not well understood. Do the distortions of a high-tax, regulated, crony-capitalist, welfare state, just screw up levels? Or do they reduce the spread of ideas behind long-run growth? My fear is "yes."

In any case, just posing the question this way argues that the dangerous "headwinds" are entirely different from the ones that Bob highlights. The returns from innovation, starting new companies, introducing new products and processes -- and in that process making established incumbents very unhappy -- are the most likely targets.

But it's also clear that ideas are public goods, or high fixed cost zero marginal cost goods. Their production and diffusion depends a lot on non-market structures, like, say, universities. (Don't jump from that observation to "they need to be subsidized," as it it's all to easy to subsidize bad ideas too.) That's another lesson of Bob Lucas' paper, which is remarkably free of economic incentives.

Finally, a warning about statistics. Here is my last picture, blown up.

As you can see, if you're just looking at GDP trends, it's hard to tell a "level" effect from a "growth" effect for several decades.

Much discussion of our current slump presumes it's a temporary "level" shock; the blue line will go back up quickly to the red line. The "stagnation" hypothesis is that we're on the blue line -- we lost about 5% of GDP in the recession, and now we're on the growth path with a lower level. That's disastrous enough. Bob warns us that we might be on the worst of the blue and black lines. That would be a huge disaster.

All said before. The graph reminds us is that it takes a long time to figure out which it is based on just eyeballing the GDP or productivity data. We have to think. Which Bob is prodding us to do.

48 comments:

Can you expand on this a little? I don't think you can argue Europe has suffered significant negative "growth effects" despite just as much if not more government involvement than the U.S (most analyses seem to argue for negative "level effects" if any). If that is the case then on what basis is this fear you describe predicated?

What? Growth in Europe has been measurably lower than growth in the US for thirty or forty years. If growth comes from innovation (vs. massive capital formation as in Asia) the worst thing you can do is to adopt European policies that restrict the process of creative destruction in both consumer and producer markets. Unfortunately that's exactly what "Progressives" want to do.

"What? Growth in Europe has been measurably lower than growth in the US for thirty or forty years."

Growth in GDP has, but not growth in GDP per capita which has been virtually identical in the EU and US since 1970 (http://www.asymptosis.com/u-s-versus-europe-whos-winning-now.html). The results stay the same even if you start from 1980 or anywhere in between so I don't want to hear anything about cherry picking. The data is from the OECD. This is even being generous since it doesn't include the Scandinavian countries who surely follow the "European model" and have had even higher growth in GDP per capita.

The reason GDP growth in the U.S. has been higher is because the population in the U.S. has increased more over the time period (which is why GDP per capita is a better statistic to compare with since it controls for population growth). There are absolute differences in GDP per capita between the EU and the U.S. even though the growth rates have been the same which are primarily driven by the fact that Americans work more hours. That sounds like a "level effect" to me.

The stats you quoted are for EU 15, which includes UK and Ireland, whose policies are more like the US, and a number of lower income countries (Greece, Spain) who enjoyed more rapid growth in catching up to the rest of Europe. If you look at a high income European country, which pursued progressive policies, like France, and compare it to the US the GDP growth rate per person was much less from 1980 to 2011 (France went from $9987 to 35600 while US went from 12249 to 49000). I would also argue that US GDP growth per person shoud be less because of substantial influx of unskilled, and often illegal immigrants.

The big change in technology was mass production of steel developed between about 1855 to 1865. It made the modern world, including railways, internal combustion engines, bridges and skyscrapers possible to a degree that cast iron and artisanal steel could never have done.

Bell Labs was a source of a lot of invention, including the transistor, but that research was subsidized by a monopoly and is now gone for ever. The same with Xerox Parc. The military funded a lot of research in the 1950s and 1960s but not as much anymore.

The big opportunities for improving quality of life probably lie in finding treatments or cures for diseases like mental illness, drug addiction, alchol addiction and diabetes. The social pay-offs would be huge even if the market pay-offs might not be and government should be putting more money into research.

CHAPTER III. Of the Accumulation of Capital, Or Of Productive andUnproductive Labour.

"But though the profusion of government must, undoubtedly, have retarded the natural progress of England towards wealth and improvement, it has not been able to stop it. The annual produce of its land and labour is, undoubtedly, much greater at present than it was either at the Restoration or at the Revolution. The capital, therefore, annually employed in cultivating this land, and in maintaining this labour, must likewise be much greater. In the midst of all the exactions of government, this capital has been silently and gradually accumulated by the private frugality and good conduct of individuals, by their universal, continual, and uninterrupted effort to better their own condition. It is this effort, protected by law and allowed by liberty to exert itself in the manner that is most advantageous, which has maintained the progress of England towards opulence and improvement in almost all former times, and which, it is to be hoped, will do so in all future times."

Perhaps it's worth characterising the sorts of policies which are most likely to belong to your trend growth-rate affecting category by:

1) does the policy constrain future policy choices in the same realm?

By this I mean "once I commit to this policy regarding X, are my future policy choices regarding X limited?" This will be the case if going from the worse policy's equilibrium to the better policy's equilibrium is NPV negative. Importantly, the limits may well be political.

For example, retrofitting suitable infrastructure to a dense (and expensive) city may well be NPV negative, even though the equilibrium is better.

2) Are the costs of the policy mistake large? And,

3) Are the mistakes able to be un-done?

In this sense, it's not bad health-care, tax, or immigration policies aren't likely to affect LR growth, unless they are permanent. But constitutions, urban planning, and (early-childhood) education are.

In regards to "The most important quantitatively in holding down the growth of our future income is rising inequality.":

1. I took a quick glance at the paper and noticed he is referring to figures from Emmanuel Saez's website to make this point. Are these the same pre-tax/pre-transfers figures from Piketty and Saez?

2. Assuming there is rising inequality, how does this inequality per se limit future potential growth? I.e., is there any evidence that an income gap, in and of itself, causes slower growth of income for any segment of the population?

Loosely related: do you have any thoughts on this, "Greece plans 'special economic zones' to boost growth"?http://www.reuters.com/article/2012/08/28/us-greece-economy-zones-idUSBRE87R09820120828

As you might have guessed, I think most of Gordon's "headwinds" have nothing to do with growth, and Piketty and Saez measures of inequality especially so. Haven't read about Greece special zones, but why not the whole country?

"Current labor law will be fully respected," he said. Greece has already slashed minimum wages to encourage the creation of new jobs. Unemployment, however, still hovers at record levels, hitting 23.1 percent in May. (Reporting by Harry Papachristou)

I'm very confused on how these zones will attract foreign investment without labor liberalization, if they're good ideas for growth "why not the whole country", and why the EU wouldn't approve it automatically and immediately.

Great post as always Professor. We got assigned the first 240 pages of your textbook as supplemental reading today, oh the joys of a graduate student. :)

Prof. Cochrane, do you really believe that high level of inequality don't matter for future growth at all????

Look at countries where inequality is really high, such as Latin American and you immediately see very inefficient political institutions. Research by Acemoglu et al., makes this point well even in terms of rhetoric acceptable by the right wing; i.e concentrated economic wealth will often lead to concentrated political power and therefore distort decision making from government institutions. The US has its own experience with the Gilded Age.

I think it would be beneficial for you to try to explain that point at length.

It's a possible story. But where did the concentrated wealth come from? The other possibility is that the causes of stagnation lead to more income inequality. Watch out for the causation - correlation fallacy. And these examples hardly support "left wing rhetoric" that an intrusive redistributionist government will lead to rapid growth. Venezuela is not doing so hot and Cuba remains a basket case.

If you look at that chart, you'll notice that GDP/capita in England starts rising shortly after the Chartist reforms were implemented and worker conditions started improving in England. (The US numbers show the jump after WWI when the US government commandeered the economy and imposed labor settlements raising wages in a variety of industries.)

I'm also suspicious about some of those six headwinds.

(1) The Industrial Revolution was triggered by a tightening work force in the 18th century. Reducing the workforce is likely to improve productivity as it makes capital investment more attractive.

(2) Education is a sorting mechanism. Stagnant wages, even in STEM jobs, are not a sign of educational deficiency.

Another issue about growth that bothers me is that the sectors of the economy that are immune to innovation and change loom larger and larger. E.g. health care is now 1/6th of the economy, and it is completely covered by governmental mandates and regulations like Gulliver tied down by the Lilliputians, with King Kong sitting on his chest. Other sectors that loom larger as time goes by are things like education, that is also tied up. And, of course there is government itself.

Health care and government may be resistant to institutional change but technological advance proceeds apace. Some is specific to health care (procedures that were once unheard of are now routine) and some is merely the application of generic technology (e.g. digital information systems) to health care applications.

Health care is in fact one area where we could reasonably look for significant growth in the standard of living of ordinary Americans through better science. What is an extra five years of active life worth?

I was rather surprised that their paper didn't reference Broda and Weinstein (2010). Mismeasurement of real GDP seems the best explanation for any apparent slow down, particularly in the years since the tech/internet boom.

I have recently released a paper that makes the exact opposite point to them, namely that from the perspective of existing models of endogenous growth, it is remarkable how close to trend stationary real GDP appears to be. It includes some evidence along the lines of your 1988 JPE paper, modified to allow for medium frequency returns to trend. It also proposes a new endogenous growth model that generates such a robust trend, despite business cycles. The paper's available here: http://users.ox.ac.uk/~ball1377/mfc.pdf (will be on RePEc soon).

Finland, Sweden, Netherlands, Norway, Austria, UK have all grown faster since 1960 and 1979 and 1995 than the United States, according to BLS data

http://www.bls.gov/ilc/intl_gdp_capita_gdp_hour.htm#chart03

why do you think that is? if structural issues mattered very much in advanced economies, wouldn't you expect all these countries to grow slower ? I am not sure, but it seems that they have more structural issues than the United States.

My guess is that they have grown faster because they have less inequality. Why does it matter? It matters because inequality reducing policies that are effective ensure that children do not get stuck at the bottom of the barrel.

Well, one basic explanation would be catch-up growth. The right wing would probably use that.

The second, is that quality of institutions and hence "structural problems" are way beyond "taxes". The worst tax is political and institutional instability. What value is a low tax rate if tomorrow the government can come in and confiscate your property?

And the countries you just mention have excellent quality of institutions with the right characteristics: stability, predictability etc.

Once you have those things, tax levels really aren't that important to be honest. If the right in the US wasn't so completely taken over by special interests you wouldn't hear this infatuation with ever lower tax levels.

Catch-up growth is always referred to catching up to countries with the highest level of income. The US is basically the starting point for comparisons.

The US is a country at the production frontier, using the latest technology. To fully make use of it a country though needs good political institutions. So for example, it doesn't matter how many good computers Saudi Arabia can buy if their people simply aren't allowed to use them in the most productive way.

Since those countries you mention had excellent institutions all they had to do was catch up to the technological level, which is mostly done through imports and as they come closer to the frontier even start to improve and innovate a bit.

I do not think it proven at all that "inequality" will effect growth one way or the other. But even if so? What is the be done? The United States has a much more progressive tax system than any or those nations do now. (here is a chart courtesy Greg Mankiw

With very high levels of inequality, China has managed pretty high growth rates of late. Economic growth depends on 2 broad factors; labour and capital. How countries mix these 2 together will yield high or low growth rates. The US has favoured capital at the expense of labour for the past 30 years, and this is beginning to catch up to the country's growth rate.As well, demographics has begun to go negative with the aging population and the throttling of immigration.

I usually don't find myself agreeing with your positions, but you're a glider pilot, so circling in the sink (declining resources/old technology)is a bad idea. Heading off to take advantage of new technologies and markets is crucial. My prediction is that the US is going to lose out to the next wave of innovation, which will probably come first in more sophisticated electricity transmission (See ABB's HVDC Lite) This is a short term trend, now pretty well underway worldwide.

Longer term, as a guest at Lawrence Berkeley National Labs, I can see that with the genomic revolution, we will be able to mimic an ever increasing range of bio-production techniques of materials that are capable of matching or even exceeding current materials. Spider silk is a good example, and here's the abstract for a really geeky piece, to show the level of sophistication required.http://www.ncbi.nlm.nih.gov/pubmed/22012252 Key take-away is the synthesis of the proteins to produce the silk. Adhesives are another area where shellfish put commercial glues to shame, and there are countless new possibilities. I don't see modified spider silk spar caps in sailplanes in the immediate future, but if we don't take advantage of the potential energy/resource efficiency and move towards living within the energy that we can gather from solar input to the planet, we're screwed.

Let me stretch the thermal/glider analogy to cover economics. We all know pilots who will wring every last inch of altitude/asset value out of a thermal,and never get out of safe gliding distance of their home field. However, success in contests depends on deciding when to abandon the comfort of a positive climb when the rate starts to decay, and stick the nose down and head off at the optimum speed to find the next area of lift/true economic growth.

I could go on and on about the state of research in this country and its negative effect on the future, but will leave you with this youtube clip. http://www.youtube.com/watch?v=NXIR9ve0JU0

(As far as gliders, I drove an ASW 20...had one of the first, and a Janus. I now only fly occasionally)

"He is also mixing constraints -- run out of ideas -- with self-inflicted wounds -- dysfunctional public education, refusing to let in immigrants, refusing to use nuclear power or GM foods."

The United States (unlike Europe) imposes very few restrictions on the use of GM foods. In 2011, the U.S. planted 170 million acres of GM crops.

However, the statement about "refusing to let in immigrants" is factually flawed. Between 2000 and 2010 14 million immigrants entered the U.S. (in spite of negative job growth). Obviously, immigration without job growth reduces per-capita GDP. However, even with job growth, immigration reduces growth. Why? Two reasons at least.

First, the immigrants that America actually gets are markedly less skilled than the U.S. population as a whole (immigration is deskilling America) and the gap is highly persistent. Second, immigration exacerbates point 5 (energy and environmental constraints on growth).

The adverse impact of immigration on education and job skills can not be easily overestimated. See the following notes

1. John Judis “End State Is California finished?” (http://bit.ly/2x2P6P)

“At the gathering, held in a plush conference room, one of the experts projected tables and graphs comparing various states. It was there that I had my own “AHA!” moment. The states with thriving educational systems were generally northern, predominately white, and with relatively few immigrants: the New England states, North Dakota, and Minnesota. That bore out the late Senator Patrick Moynihan’s quip that the strongest factor in predicting SAT scores was proximity to the Canadian border. The states grouped with California on the lower end of the bar graph were Deep South states like Mississippi and Alabama with a legacy of racism and with a relative absence of new-economy jobs; states like West Virginia that have relatively few jobs for college grads; and states like Nevada, New Mexico, and Hawaii that have huge numbers of non-English-speaking, downscale immigrants whose children are entering the schools. California clearly falls into the last group, suggesting that California’s poor performance since the 1960s may not have been due to an influx of bad teachers, or the rise of teachers’ unions, but to the growth of the state’s immigrant population after the 1965 federal legislation on immigration opened the gates.”

“The overall PISA scores of American students are lowered by the poor results for blacks and Latinos, who make up 35 percent of America’s K-12 student population. Asian-American students have an average score of 541, similar to those of Shanghai, Hong Kong, Japan and South Korea. The non-Hispanic white American student average of 525 is comparable to the averages of Canada (524), New Zealand (521), and Australia (515). In contrast, the average PISA readings score of Latino students is 446 and black students is 441.”

“"If you ask why California schools have gone from the nation's best to among its worst, I would say the influx of non-English speaking immigrants tops the list of reasons," says Ms. Augustine, a 30-year teaching veteran.”

4. "US Educational Achievement on International Assessments: The Role of Race and Ethnicity" (http://bit.ly/pnRSd4)

"The debate about the performance of US students on international assessments of educational achievement routinely fails to account for one consistently stark result: US achievement is bifurcated between a group of high-performing Asian and white students and an exceptionally low-performing group of black and Hispanic students. By summarizing results across 20 major international tests conducted since 1995, this research paper shows that when US racial and ethnic groups are separately compared with other countries, Asian and white students regularly perform at or near the top of international rankings, while black and Hispanic students typically rank at or near the bottom. Furthermore, the United States has a substantially larger minority population than all other developed countries, and minority status is not synonymous with internationally comparable factors such as socioeconomic level or immigrant status."

"What I have learned recently and want to share with you is that once we correct (even crudely) for demography in the 2009 PISA scores, American students outperform Western Europe by significant margins and tie with Asian students. Jump to the graphs if you don't want to read my boring set-up and methodology."

The author shows little improvement in education attainment across generations of Mexican immigrants.

"The education of people of Mexican origin in the United States lags well behind the U.S. norm. In 2000, 86.6 percent of native-born Americans had graduated from high school. The rates for the foreign-born population in the United States varied from 94.9 percent for Africans, 83.8 percent for Asians, 49.6 percent for Latin Americans overall, and down to 33.8 percent for Mexicans, who ranked lowest."

7. "Honesty from the Left on Hispanic Immigration A provocative new book doesn’t flinch from delivering the bad news" (http://bit.ly/4CBWWT)

"Hispanics are underachieving academically at an alarming rate, the authors report. Though second- and third-generation Hispanics make some progress over their first-generation parents, that progress starts from an extremely low base and stalls out at high school completion. High school drop-out rates—around 50 percent—remain steady across generations. Latinos’ grades and test scores are at the bottom of the bell curve. The very low share of college degrees earned by Latinos has not changed for more than two decades. Currently only one in ten Latinos has a college degree."

A few notes on GM crops. The 69 million U.S. hectares (not acres) in 2011 was 43.1% of the world total of 160 million hectares. In 1996 the global total was only 1.7 million hectares.

See also "In 2010, more genetically modified crops once again" (http://bit.ly/RqJr8F)

"In the USA, the cultivation of genetically modified (GM) maize, soybeans and cotton continues its increase. In 2010, the share of GM crops increased to approximately 90 per cent. Fields planted with GM varieties added up to 64.3 million hectares."

In other words, in the U.S. at least the GM revolution is essentially over. Note that it appears that GM crops have been adopted faster than hybrid corn was. See "A Farm Level Perspective On Agrobiotechnology: How Much Value And For Whom?" (http://agbioforum.org/v2n2/v2n2a01-editor.htm). Quote

"Even the optimists among biotechnology proponents have been caught off guard by the extremely fast farm-level adoption of bioengineered crops. In 1999, just four years from commercial introduction, an estimated 40% of the total United States (US) corn, soybean and cotton acreage were planted with herbicide- and insect-resistant bioengineered crops. To put this level of adoption in perspective, one may consider it against that of the most dominant agricultural technology of the past—hybrid corn. "

I think a discussion of intellectual property would be relevant. Bill Gates claimed that if software had been patented when he started out, he could have never gotten anywhere. Now software companies invest huge amounts in amassing patent portfolios so they can countersue when they inevitably cross someone else's patents. That's the perspective I get from reading folks in the software world, other industries will differ. Matthew Yglesias had an interesting post on how different conceptions of innovation will lead to different conclusions about the monopoly rents secured by the patent system, but I can't easily find it now.

The golden age of software development was before software patents were recognized. The golden age of computer development was after the basic patent was struck down. The golden age of aircraft development was after the Wright brothers' patent expired.

Invalidating software patents would probably be a net positive for growth. As for other areas - patents have a checkered historical record as to whether they help or hurt progress.

If growth is based upon innovation, then I do not see it declining, but rather increasing as we are on the cusp of several groundbreaking technologies, in many areas.

I think economic growth is caused mostly by such innovation, but also by investment by business and entrepreneurs. We may be in a temporary lull because of the reluctance of business to make new investments.

You brush off Gordon's points about education and inequality fairly quickly and apparently without much thought.

First, it certainly seems that many innovations come and will come from educated people. Therefore, the more well-educated (emphasis on well) people we have, the more growth we will have. This definitely is a "growth" effect not a "level" effect.

Second, a lot of inequality can be seen as a sign that our education system isn't working well. Should the distribution of productivity amongst people really look like our income distribution, or is the distribution just a result of many people not receiving enough education or growing up without parents that are forced to work too many hours to take care of their children?

Alternatively, inequality can itself have a "growth" effect. Recent psychological research (although, granted, still far from conclusive) shows that those lower down in a hierarchy tend to become more depressed, overweight (a study on monkeys showed that being beneath others can actually cause more fat to collect around the stomach), and perhaps less productive. Therefore, a more unequal society may cause some to feel less motivated to come up with the next great idea. This is not a confirmed story, but it is certainly plausible and supported by some evidence.

(1) "The optimistic lesson of growth theory is that, no matter how badly you screw up level effects, growth will bail you out eventually."

IMHO, the optimistic lesson is that, no matter how badly you screw up level effects, you can always return to the frontier by reversing your mistakes, e.g. China: Adoption of communism is "badly screwing up", but once communism is abandoned, catch-up growth (much faster than long-run frontier growth trend) brings you back to the frontier, i.e. all "level" type mistakes are completely reversible.

Adopt any bad policy, you get a lower long-run level; abandon the policy, and you go back to the original long-run level.

(2) "Do the distortions of a high-tax, regulated, crony-capitalist, welfare state, just screw up levels? Or do they reduce the spread of ideas behind long-run growth? My fear is "yes.""

It follows from the logic of (1) that the regulated, crony, welfare state can only reduce long-run growth irreversibly if it is indeed adopted globally. If there is at least one place on earth that doesn't have the regulated crony state, it is this place that will then define the new frontier, and thereby allow other countries to catch up to that frontier at a later point in time.

But take a look at Singapore or Hong Kong. Is there much new technology coming out of these two places that have lead the common indices of economic freedom for so many years now? I don't know any. AFAIK, both are only well known as business hubs. I see that Singapore has both a higher GDP per capita and a higher growth rate than the US, but it might just be that they are still catching up technology-wise, but their level is just much higher than the U.S.'s because of better governance.

Of course it is also possible that those places are simply too small to provide for the economies of scale needed for innovation.

I think you misunderstand the idea of "ceding the frontier." It means that, if China is able to have long-term growth of 2.5%, then so can we. But, that doesn't mean that our contribution to that growth is insignificant. The more countries with innovating populations, the more quickly the frontier will be pushed outwards, and the larger long-run growth for everyone will be. Unless you believe that people in China are producing the exact same innovations as Americans, and so for both of us to innovate is just redundant. However, I don't think this is the case, especially given globalization and multinational corporations.

I cannot stress how much I agree with this post. I agree with the source of prosperity, the role of printing and the future potential of the Internet. I also agree with the conclusions of the real headwinds as institutional barriers in the creation, dissemination and building upon of ideas.

I will add that economic progress requires change, and change creates winners and losers, and that incumbents are often the primary losers. Incumbents are better organized than prospective future winners, and thus actively suppress change. Thus they actively suppress progress. As incumbents throw more sand into the gears of economic advance, the frontier of economic progress moves to somewhere without incumbents.

In the midst of a financial crisis it is very easy to come to all kinds of incorrect conclusions. it is also possible to overreact and do more harm than good. We won't know what is going on until around 2015-16 when the world has had time to fully adjust to the financial shock that began in 2008.

To predict the death of growth based on the last few years is foolish. Let's talk again in 2016.

I've wondered how much of a permanent effect from the current very slow period of econoimc growth will be perpetuated via lower household formation and lower birth rates. A half generation of kids in their 20s might have permanently lower fertility rates as they struggle through economic and social uncertainty. Would this not be a permanent (or at least very long lived) shock to economic growth...

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.

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About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a professor at the University of Chicago Booth School of Business, a Senior Fellow of the Hoover Institution, and an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!